Quiz 3/4

Citi press release: Citi commits support facility for Citi-advised SIVs

-Citi committed to providing a support facility that will resolve uncertainties regarding senior debt repayment currently facing the Citi-advised Structured Investment Vehicles (SIVs) -Citi was selling products to SIVs, and a lot of them failed (debt was downgraded and asset-backed commercial paper became less liquid) -the question was if Citi would bail them out (Citi wasn't legally obligated to, but they elected to do so for reputation purposes) -because Citi absolved the loss, they had to consolidate some of the SIVs assets -see page 12 for a summary of the VIE rules -the phrase moral recourse is sometimes used to discuss circumstances in which one company may provide support, even though legally they may not be obliged to do so -for example, it may be the case that in order to maintain their reputation and their ability to do similar deals in the future, Citi decided to provide support to their SIV -presumably, the possibility of such an implicit guarantee should also be taken into consideration when evaluating whether variable interest entities should be consolidated

with and without calculation example

-Mega Online pays $600,000,000 for 100% of a company's two reporting units: "media" and "print" -Mega Online believes that their online service will be more valuable as a result of the acquisition, by a value of $80,000 1. how much Goodwill is allocated to each reporting unit if the purchase price of the Media reporting unit was $340,000,000, and that the purchase price of the Print reporting unit was $180,000,000? -total Goodwill from the transaction: total purchase price of 60,000,000 - (fair value of total assets - fair value of total liabilities) -this would be allocated to each reporting unit: -Online: $80,000,000 (as specified in the problem, it is the increase in value) -Media: allocated purchase price to Media as specified in the problem - (Media's fair value of assets - fair value of liabilities) -Print: allocated purchase price to Print as specified in the problem - (Prints's fair value of assets - fair value of liabilities) -these numbers add up to total Goodwill -note that in this example, some of the Goodwill generated in the transaction is allocated to a previously existing reporting unit

Disney example

-a VIE is consolidated in the F/S if the company has the power to direct activities that most significantly impact the economic performance of the VIE and has the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant -Disney consolidates the Hong Kong and Shanghai resort because they have the ability to direct the day-to-day operating activities and they extract money from them through management fees -therefore, they consolidated (note that the company only had a 47% and 43% ownership interest)

reporting unit

-a component of a business for which discrete financial information is available and for which management regularly reviews the operating results -a reporting unit may be a segment, or it may be a layer of a business lower than a segment -goodwill arising from a combination may be allocated to multiple reporting units (each reporting unit has a mini purchase price allocation) -it is also possible that Goodwill may be allocated to a reporting unit that does not receive any of the assets or liabilities acquired in the combination

Goodwill allocated to a reporting unit not receiving any of the assets and liabilities acquired in a combination

-could be done because the acquisition enhances an existing reporting unit, such as having a synergy -if Goodwill is to be allocated to a reporting unit not receiving any of the assets and liabilities acquired in a combination, FASB #142 suggest a "with and without" calculation -under this approach, the difference between the fair value of a reporting unit after the combination and the fair value of the reporting unit before the combination would be the amount of Goodwill assigned to that reporting unit

KPMG variable interest entity flowchart at the time FIN 46/46R was issued

1. does the evaluating entity qualify for a scope exception? 2. is entity or structure being evaluated a VIE? 3. does evaluating entity have a variable interest in the VIE? (if not, the process is stopped) 4. does evaluating entity have a majority of the variable interests? (if not, the entity is not the primary beneficiary and does not have to consolidate) -if yes, the evaluating entity is the primary beneficiary and needs to consolidate -there isn't necessarily a primary beneficiary each time

SFAS #131

-requires disclosures for qualifying operating segments

approach for determining how much Goodwill should be allocated to an acquired reporting unit

1. determine the purchase price for each reporting unit 2. determine the fair values of the assets and liabilities of the acquired reporting unit 3. calculate Goodwill for a reporting unit (the difference between the purchase price and the fair value of the net assets acquired)

FIN 46R

-FIN 46R indicates that the risks and rewards of a relationship should be examined when determining whether or not an entity should be consolidated -examples of financial interests that would convey economic risks and rewards associations with another entity could be from loans, leases, service contracts, call options, credit enhancements, derivatives, and guarantees

article: Kraft Heinz's Goodwill charge tops consumer-staples record

-Kraft Heinz had a high Goodwill impairment charge -it was a costly process

transitional Goodwill Impairment test (SFAS #142)

-SFAS #142 also required a transitional Goodwill Impairment test for all Goodwill that existed as of the beginning of the year in which a firm adopted SFAS #142 -if previously existing Goodwill was determined to be "impaired" as a result of the transitional test, the write-down was considered to be a change in accounting principle, and therefore, was classified below the line on the income statement in accordance with accounting standards that existed at that time -once transitional Goodwill was tested for impairment, in subsequent periods, any remaining transitional Goodwill would be tested for impairment in a manner consistent with Goodwill arising from business combinations recorded under FASB 141 -if, in subsequent periods, Goodwill existing on the date of adoption of SFAS #142 is determined to be impaired, the impairment is classified "above the line" on the income statement

unusual situations

-a corporation should use judgement about unusual situations when deciding whether or not a segment should be disclosed, and should think about consistency in reporting/what is normal -if a segment does not meet any of the criteria (because, say, profits were unusually low) but would ordinarily have met at least one of the criteria, consistency in reporting suggests that the results and position of that segment should still be reported -likewise, if a segment satisfies one of the criteria because of some unusual circumstance, but would ordinarily not be required to disclose separately, the information related to that segment need not be disclosed (an explanation of why that segment's results are not being disclosed would be appropriate)

special purpose entity: Soczek definition

-a trust that is designed to buy the receivables that a company is selling

example: JDS Uniphase

-consolidated statement of operations has a "reduction of goodwill and other long-lived assets" of $50 billion -but the consolidated balance sheet was "Goodwill and other intangible assets" of only $7 billion

MegaOnline/Media Gian example if they had adopted ASU 2017-04 when testing the goodwill of the Media reporting unit for Impairment

-since the fair value of the reporting unit is less than the carrying value, Goodwill may be impaired by a maximum of the difference, which is $70,000,000 -since there is $90,000,000 of Goodwill in the Media reporting unit (an amount in excess of the maximum impairment), a Goodwill Impairment in the amount of $70,000,000 should be recorded, and the remaining Goodwill after the impairment will be $20,000,00

example: Apple

-the company manages its business primarily on a geographic basis (rather than by product)

another FIN46/46R scope exception

-when the Variable Interest Entity Model was first introduced, it was possible that firms did not have the necessary information in order to comply with the rules -as a result, the FASB indicated that FIN 46/46R would not be applied when "after making an exhaustive effort, the entity is unable to obtain the information necessary to determine whether the entity is a variable interest entity, to determine whether the enterprise is the variable interest entity's primary beneficiary, or perform the accounting required to consolidate the variable interest entity for which it is determined to be the primary beneficiary -the scope exception in this provision applies only as long as the reporting enterprise continues to be unable to obtain the necessary information -basically saying that if you don't have the necessary info (you need to constantly reevaluate it), then you don't have to consolidate

inter segment activity and trying to avoid disclosures

-while the reporting requirements for operating segments are quite detailed, the data reported must be viewed in an appropriate context -in particular, the operating segment data will utilize transfer prices for inter segment activity and the allocation of common costs -as noted in most cost accounting courses, the application of these techniques will often vary depending on the desired objective -to the extent that managers wish to mask certain segment results or not report the results of certain segments, there may be enough flexibility within the firm's accounting to enable them to obtain their objective -ex. a firm could avoid disclosing a segment by adjusting the "internal transfer price" for the product/service sold internally by that segment, which will reduce the inter segment revenue beneath the 10% threshold of the revenue test, and would reduce operating profit so that the segment no longer meets any of the three tests (but the 75% test will still be satisfied) -therefore, internal transfer cost allocation can be used to adjust disclosures

operating segment disclosure requirements

-when a segment satisfies one of the tests described above, the following income statement items must be reported for that operating segment if they are included in the determination of segment profit or loss (companies may not have all of these things at a segment level, and that's okay): -revenues from transactions with external customers -revenues from transactions with other segments -interest revenue -interest expense -depreciation, depletion, and amortization -unusual items -equity int he net income of invests accounted for by the equity method -income tax expense/benefit -extraordinary items -significant non cash items other than depreciation, depletion, and amortization -companies are NOT required to disclose cash flow information about their operating segments -nevertheless, the required income statement information may be useful in enabling the reader of the segment information to estimate cash flow information by segment -there are a lot of requirements for the income statement -for the balance sheet, you only need to report total assets of each segment, and maybe CapEx -if part of a segment's assets relate to an investment for which it uses the equity method, the amount of assets related to such investments must be disclosed -also, if applicable, the amount of capitalized expenditures of a segment must be disclosed -further, an enterprise must reconcile operating segments' revenues to (consolidated) total revenues, operating segments' profits and losses to (consolidated) total income before taxes, and total operating segments' assets to (consolidated) total assets -if an enterprise operates in foreign countries, it must report revenues and assets attributable to each material geographic area (a geographic area is defined by FASB 131 as an individual country, but in practice firms tend to report by region) -if any customer accounts for 10% or more of external revenue, the firm must disclose the revenue from each such customer by segment (disclose the amount/existence of the revenue, but don't need to say the customer's name)

summary of the steps of determining whether an entity should be consolidated

Step 1. is the entity a VIE? Step 2. should they consolidate? -consider: does the enterprise have a variable interest in the VIE? will they absorb losses/gains?

operating segment

-a component of an enterprise engaged in business activity for which it may earn revenues and incur expenses, about which separate financial information is available that is evaluated regularly by the chief operating decision makers in deciding how to allocate resources and in assessing performance (side note: the chief operating decision maker could be a CEO, CFO, or someone else who evaluates financial information on a regular basis) -multiple operating segments may have similar characteristics, such as a retail corporation having hundreds of stores -information related to similar operating segments may be aggregated (prior to applying the tests described later) only if the segments are similar in each of the following areas: -the nature of the products and services provided -the nature of the production process -the type or class of customer -the methods of product or service distribution (such as online vs. retail) -lastly, if applicable, the nature of the regulatory environment -rule: financial information related to an operating segment must be reported for any segment that satisfies at least one of the following criteria: 1. revenue test: its revenue (including internal transfers/sales as well as sales to external customers) exceeds 10% of the combined revenue of all of the firm's operating segments 2. profit or loss test: the absolute amount of the operating segment's profit or loss exceeds 10% or more of the greater, in absolute amount, of: -the combined operating profit of all operating segments that did not incur a loss -the combined operating loss of all operating segments that did incur a loss 3. identifiable assets test: its identifiable assets equal 10% or more of the combined assets of all operating segments (segment assets are those assets used exclusively by the segment and any allocated portion of assets shared by two or more segments) (4). in addition, FASB 131 requires firms to disclose segmented results identifying sales equal to at least 75% of enterprise sales (to unaffiliated customers) -for that rule, you need to look at the segments collectively to see if it gets to the 75% threshold in aggregation -if the 75% wasn't met, disclosure of additional segments would be required until the 75% gets was met -this means that the company would have to pick out another segment(s) at their discretion/choice to get them to the threshold (the segment to add wouldn't have met any of the other tests)

FIN 46R journal article: in FCC Auctions of Airwaves, Gabelli was behind the scenes

-a demonstration of the situation the FASB was trying to address -government was auctioning off air waves and created a small business discount -Gabelli, a large wealthy money manager, gave money to small businesses to invest and so they received the small business discount despite their dependence on Mr. Gabelli, whose extensive assets would have made him ineligible for such breaks -then, Gabelli's entity absorbs the majority of the profit through fees -the question is if Gabelli cheated in some form (the FCC didn't say small bidders couldn't borrow from big businesses, and many other bidders did, but they did say backers couldn't control the bidding firms) -Gabelli should have consolidate these entities because they would be unable to sustain their operations alone -a legal lawsuit alleges that in the FCC auctions, affiliates formed small businesses that got them federal discounts they shouldn't have, since the bidding firms weren't actually independent

FIN 46: Consolidation of Variable Interest Entities

-as a result of SOX, in January 2003, the FASB issued FIN 46 in an attempt to remedy some of the perceived flaws that enabled firms to structure transactions in order to avoid consolidation -this document was modified by FIN 46R, issued in December 2003 -the concept underlying the Interpretation is that exposure to the economic risks and rewards of an entity reflect the essence of an ownership position -historically, an investor would face this exposure if they took an equity position in an entity -however, increasingly, other mechanisms have been used which result in external parties facing those same risks and rewards without having (or having a minimal) equity position -while the Exposure Draft preceding FIN46 was primarily focused on SPEs, the FASB ultimately concluded that using this terminology may result in confusion as there seemed to be no commonly accepted definition of what an SPE was -for new VIEs, the standard should be applied immediately -for old VIEs, they had 1/2 a year to comply FIN46 was met with a lot of resistance, and the implementation dates were deferred -instead, FIN46 defined a new type of entity, a variable interest entity

goodwill impairment article: goodwill impairment, open to interpretation, again (2010)

-at issue is whether companies should determine the fair value of a reporting unit, and thereby the value of the related goodwill, based on either the unit's equity value or its enterprise value (in general, enterprise value is the sum of the fair value of debt and equity) -it was suggested to use enterprise value -is it possible for a company to have negative shareholder's value? yes (ex. a reporting unit may have negative shareholders' equity as a result of unrecognized assets such as intangibles that have significant value but don't figure into the equity equation) -is it possible for a reporting unit to have a negative carrying value? no

testing for Goodwill impairment (pre-ASU 2011-08)

-at the end of each year, firms must test Goodwill for impairment -it is a two-step process 1. the fair value of a reporting unit is compared to the carrying value of the reporting unit, including goodwill -if the fair value of a reporting unit is greater than the carrying value of the reporting unit, the goodwill for that reporting unit is assumed "not impaired," and no additional testing is necessary -however, if the carrying value of a reporting unit is greater than the fair value of the reporting unit, a second level of testing is required 2. if the carrying value of a reporting unit is greater than the fair value, the fair value of the Goodwill is imputed -you have already calculated the fair value of the reporting unit, and need to calculate the fair value of the net assets at the time you are performing the goodwill impairment test -imputed fair value of Goodwill: fair value of the reporting unit of the entity - the fair value of the net assets of the reporting unit -if the imputed fair value of the Goodwill is less than the carrying value of the Goodwill, the Goodwill is written-down by an amount equal to the difference between the carrying value and the fair value -when measuring the fair value of a reporting unit, FASB 142 suggests that quoted market prices are the best source of fair value information -if no market values are available for a reporting unit, a discounted cash flow approach may be utilized to estimate fair value -alternatively, a reporting unit may be valued using a multiple of earnings or revenue if an entity that has comparable operations and economic characteristics is observable and the relevant multiples of the comparable entity are known

article: subprime lenders get big accounting break at the SEC

-banks securitized a lot of receivables and didn't consolidate the entities that had them -the SEC didn't want the bank to foreclose anything -a lot of people thought banks should lower the value of the loan to equal the value of the house (basically loan forgiveness, which is considered taxable income and you would need humans to interfere to judge the value of the house) -the SEC granted the subprime-lending industry a huge exemption from the normal rules for off-balance sheet accounting -many lenders recorded upfront profits by selling loans in bulk to off-balance sheet trusts, known as QSPEs, which then repackaged the loan pools into mortgage-backed securities -the trusts are supposed to be beyond the lender's control -by following new guidelines issued last month by a banking-industry group, services will be allowed to modify subprime mortgages where defaults are reasonably foreseeable, without jeopardizing the trusts' off-balance sheet treatment -the accounting standard at issue is FASB 140, which says that QSPEs should be brain-dead vehicles that have automatic responses and don't need to exercise much discretion -however, now the services are using a lot of discretion for mortgage modification -did not require lenders to consolidate receivables that were restructured

SFAS #167: Amendments to FASB Interpretation 46R

-effective for fiscal years beg after 2009 -this statement revisited the approach used to determine whether an entity should consolidate a variable interest entity -while the essence of the approach remains the same, the criteria are somewhat more qualitative in nature rather than quantitative in nature -at the time of the statement, there were no more qualifying special-purpose entities (was gotten rid of in 166) -this statement amends 446R to require an enterprise to perform an analysis to determine whether the enterprise's variable interest or interests give it a controlling financial interest in a variable interest entity -listed a new definition of a primary beneficiary -new definition: the primary beneficiary of a variable interest entity has both of the following characteristics: (1) the power to direct the activities of a variable interest entity that most significantly impact the entity's economic performance and (2) the obligation to absorb losses of the entity that could potentially be significant to the variable interest entity or the right to receive benefits from the entity that could potentially be significant to the variable interest entity -additionally, an enterprise is required to assess whether it has an implicit financial responsibility to ensure that a variable interest entity operates as designed when determining whether it has the power to direct the activities of the variable interest entity that most significantly impact the entity's economic performance -requires ongoing assessments of whether an enterprise is the primary beneficiary of a VIE (FIN46 only required an assessment when a specific event occurred) -amends 46R to eliminate the quantitative approach previously required for determining the primary beneficiary of a VIE, which was based on determining which enterprise absorbs the majority of the entity's expected losses, receives a majority of the entity's expected residual returns, or both -this statement replaces the quantitative-based risks and rewards calculation for determining which enterprise, if any, has a controlling financial interest in a VIE with an approach focused on identifying which enterprise has the power to direct the activities of a VIE that most significantly impact the entity's economic performance and the obligation to absorb losses of the entity or the right to receive benefits from the entity

FIN46 scope exceptions

-exempts you from consolidating if you meet the criteria -while most relationships are subject to FIN46, there are a number of entities that are exempted -ex. non-profit organizations, employee benefit plans, and qualifying SPEs as described in FASB 140 -a qualifying SPE is a distinct trust or vehicle that has no autonomy (significantly limited activities, etc.) -any SPE satisfying the (long) list of criteria doesn't need to be consolidated

estimating free cash flow for a segment

-free cash flow = NI + depreciation + amortization - CapEX -NI can be called "operating profit" -you could use this historical data of free cash flow as a starting point for projecting future period cash flows, which ultimately could be used as a starting point of a discussion of the appropriate valuation for the segment -ex. if you determined that at the end of a year, large, "pure play" publishing corps trade at a multiple of 7 times FCF, you might infer that the publishing division is worth 7x FCF projected -further, if Tribune Company uses their segments as reporting units for purposes of determining whether Goodwill is impaired, the type of calculation provided above might prove useful in assessing whether the Tribune Company may be facing a Goodwill Impairment charge in the future -example: 1. assuming the allocation of liabilities is proportionate to their assets, they would have liabilities of: (total assets of the segment/total assets of the company) * (total assets of the company - ?) 2. this would result in an estimated carrying value for the segment of the total assets - the total liabilities you found in 1 3. as long as one could justify a multiple of at least 3.66 (net carrying value / FCF), no goodwill impairment would seem to be in order for the publishing segment -if the estimated value of the publishing division was less than the carrying value, the disclosure of goodwill by segment could potentially be used to estimate the maximum amount of a goodwill impairment

variable interest entity

-has either of the following characteristics: 1. the total equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties (you are undercapitalized/don't have enough equity, so the equity investment is not greater than the expected losses of the entity -an equity investment of less than 10% of the entity's total assets would mean that the entity could not be independent and needs subordinated financial support in addition to the equity investment, unless the equity investment can be demonstrated to be sufficient in at least one way (the entity has demonstrated that it can finance its activities without additional subordinated financial support, the entity has at least as much equity invested as other entities that hold only similar assets of similar quality and operate with no additional subordinated financial support, or the amount of equity invested in the entity exceeds the estimate of the entity's expected losses based on reasonable quantitative evidence) 2. as a group, the holders of the equity investment at risk lack any one of the following three characteristics of a controlling financial interest -(1) the direct or indirect ability to make decisions about an entity's activities through voting or similar rights (meaning they have no voting rights) -(2) the obligation to absorb the expected losses of the entity if they occur (the investor or investors do not have that obligation if they are directly or indirectly protected from the expected losses or are guaranteed a return by the entity itself or by other parties involved with the entity) -(3) the right to receive the expected residual returns of the entity if they occur (the investors do not have the right to share in the upside) -the initial determination of whether an entity is a variable interest entity shall be made on the date that an enterprise becomes involved with the entity, and should include change sin the structure of the entity that are anticipated at the time that the involvement originates

FIN46 example

-if XYZ Consulting does not find clients, ABC will pay them to provide consulting services to them, essentially bearing the cost of XYZ's labor, and thus seemingly absorb some if not all of XYZ's downside risk -if XYZ is successful in finding clients, then ABC gets 50% of any of XYZ Consulting's Net Income, so ABC shares in their upside -under prior GAAP, ABC wouldn't need to consolidate XYZ since they does not own any of the equity of XYZ -under FIN46R, it may be possible

variable interest (in a variable interest entity)

-if the entity is assessed as being a VIE, the next step in determining whether it should be consolidated is determining whether the party of interest has a variable interest in the VIE -a variable interest in a VIE is a contractual, ownership, or other pecuniary interest in an entity that changes with changes in the entity's net asset value -therefore, a fixed claim on the VIE, such as a loan in which the repayment terms are fixed, would not be a variable interest, even though the value of that loan would presumably be impacted by the NAV of the entity -once the variable interests have been identified, the rule for whether or not to consolidate the VIE is as follows: "an enterprise shall consolidate a variable interest entity if that enterprise has a variable interest (or a combination of variable interests) that will absorb a majority of the entity's expected losses if they cover (1/2 or more), receive a majority of the entity's expected residual returns, if they occur, or both... if one enterprise will absorb a majority of a variable interest's entity's expected losses, and another enterprise will receive a majority of that entity's expected residual return, the enterprise absorbing a majority of the losses shall consolidate the VIE" -per FIN46, the interest of Related Parties should be included when considering whether the majority threshold has been met

goodwill for private companies

-in 2014, the FASB issued ASU 2014-02, which provided a Goodwill reporting alternative for Private Companies -the ASU was issued based upon the work of the Private Company Council -private company exception: private companies can elect to amortize goodwill over 10 years, or for a shorter period if they can demonstrate that it is more appropriate -if they do amortize, goodwill would be tested for impairment only when a triggering event occurs -so it is no longer the case that all companies report goodwill on the balance sheet indefinitely

goodwill impairment testing changes again: ASU 2017-04:

-in January 2017, the FASB issued ASU 2017-04: Simplifying the Test for Goodwill Impairment -eliminated step 2 from the goodwill impairment test (which measured a goodwill impairment loss by comparing the implied fair value of a reporting unit's goodwill with the carrying amount of that goodwill, requiring them to determine the fair value at the impairment testing date of its assets and liabilities) -instead, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount -an entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit -additionally, an entity should consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable -in summary, the magnitude of the write-off is limited to existing goodwill on the balance sheet -because these amendments eliminate step 2, they should reduce the cost and complexity of evaluating goodwill for impairment -we are in the transitional period for this guidance right now

allocation of Goodwill and impairment testing (pre-ASU 2011-08)

-initially, we have determined the amount of Goodwill that is recognized as a result of recording a business combination (goodwill: excess of consideration paid over the fair value of net assets) -SFAS #142 required that the aggregated Goodwill resulting from a business combination should be assigned to reporting units -it also required any Goodwill that appeared on a Consolidated Balance Sheet at the time the firm adopted SFAS #142 to be assigned to a reporting unit

update: ASU 2019-06

-issued in 2019 -allowed non-profit entities the same option as private companies (so they are also allowed to amortize Goodwill over a period not greater than 10 years) -in general, it is possible that the rules related to Goodwill could change again, as the FASB added "Identifiable Intangible Assets and Subsequent Accounting for Goodwill" to their agenda

SFAS #166

-issued in June 2009 and effective for fiscal years beginning after November 15, 2009 -eliminates the concept of a qualified SPE -accordingly, any such entity that was not required to be consolidated under the QSPE concept must be re-examined to determine whether consolidation is appropriate

Accounting Standards Update: ASU 2011-08

-issued in late 2011 -modified the rules related to Goodwill Impairment testing, sometimes referred to as the "fair value bypass" -ASU 2011-09 allows for a subjective assessment of whether it is "more likely than not" that the fair value of a reporting unit is less than the carrying value of a reporting unit (if it is more likely than not that you will fail step one) -if a firm believes it is more likely than not that the fair value of a reporting unit is less than the carrying value, the firm is required to proceed with the two step Goodwill Impairment test required previously -if a firm does not believe that it is "most likely than not" that the fair value of a reporting unit is less than the carrying value, no further testing is required -an entity may assess qualitative factors to determine whether it is more likely than not (that is, a likelihood of more than 50%) that the fair value of a reporting unit is less than its carrying amount, including goodwill -in evaluating whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, an entity shall assess relevant events and circumstances, including macroeconomic conditions such as a deterioration in general economic conditions on limitations on accessing capital, industry and market considerations such as an increased competitive environment, cost factors such as increases in raw materials, overall financial performance such as declining cash flows, other relevant entity-specific events such as changes in management or litigation, events affecting a reporting unit such as an expectation of disposing of all or part of a reporting unit, or a sustained decrease in share price -note that this list is not exhaustive -if, after assessing the events such as those described, an entity determines that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then the first and second steps of the goodwill impairment test are unnecessary -if an entity determines that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the entity shall perform the first step of the two-step goodwill impairment test

Tribune Company

-publishes the Chicago Tribune, but owned other assets/had diverse lines of business, such as media companies -everything is grouped together on the partial consolidated balance sheet -income statement shows disaggregated revenue for publishing, but it's not really broken down -the segment footnote is where they provide info about how they do their business -they have two segments: 1. publishing 2. broadcasting and entertainment -this one includes TV, radio, and the Chicago Cubs baseball team -this may be creatively grouped together so that they don't have to separately disclose the baseball team -they disclose that no single customer provides more than 10% of the company's revenue -the segment footnote is what includes all of the required disclosures

segment reporting

-segment reporting is about whether or not companies need to disaggregate -many firms operate in multiple lines of business and in multiple geographic regions and while investors may want information about the various product lines, industries, and geographic regions in which the firms operate, this information will not usually be found in the consolidated financial statements -accordingly, many investors would like "disaggregated" information about the firm in order to more accurately evaluate the prospects of the firm and to assess any changes in the composition of the business over time -however, firms may be reluctant to reveal decomposed information about their operations for any number of reasons (a firm would not want to reveal its most profitable segments in fear of competitors entering into their profitable lines of business or a revelation of such information may result in undesired takeover attempts if a raider believes that the sum of the parts is greater than the whole -current GAAP for segment reporting was established by SFAS #131, which superseded SFAS #14 and was effective for fiscal years beginning after Dec 15, 1997 -segment information is required to be disclosed on an interim (aka quarterly) basis -prior to the issuance of SFAS #131, firms were required to report information by "industry," and defined an industry as "a component of an enterprise engaged in providing a product or service or a group of related products or services" -this definition gave firms great latitude in terms of how they aggregated information by industry -SFAS #131 attempted to reduce this latitude by requiring disclosures for qualifying operating segments

disclosure requirements of FIN46

1. disclosure requirements for the primary beneficiary: -the nature, purpose, size, and activities of the VIE -the carrying amount and classification of consolidated assets that are collateral for the VIE's obligations (if anything is listed as collateral) -lack of recourse if creditors (or beneficial interest holders) of a consolidated VIE have no recourse to the general credit of the primary beneficiary (you have to disclose a lack of recourse) 2. en enterprise that holds a significant variable interest, but is not the primary beneficiary (does not need to consolidate), shall disclose: -the nature of its involvement with the VIE and when that involvement began -the nature, purpose, size, and activities of the VIE -the enterprise's maximum exposure to loss as a result of its involvement with the VIE

example: AOL Time Warner

-the company had a lot of write-offs, reporting a large loss that includes a charge to reduce the carrying value of the company's goodwill -one thing that is relevant iim if it violated any loan covenants: AOL had a debt covenant that required them to have a certain amount of shareholder's equity left -they ended up getting the debt covenant waived -possible balance sheet management -income statement: had two goodwill impairment line items: "impairment of goodwill and other intangible assets" at the end of 2002 and "cumulative effect of accounting change" of $54 at the beginning of the year. reported a los of $98 in 2002, which is a very large number -they have some goodwill left over for a number of their reporting units (if you have some goodwill left, you would assume that you wrote down the fair value of the reporting unit to its carrying value??) -the footnotes related to Goodwill and Intangibles seemingly provide information regarding the internal valuation of a firm -for instance, given the fact that all of AOL TimeWarner's Goodwill was not considered impaired, if we make the assumption that the book values and fair values of their assets and liabilities are the same, we could infer that the internal estimate of the fair value was at least $52.817 billion -in other words, if it was worth less, more Goodwill probably would have been written off -in turn, given that they have about $4.3 billion shares outstanding, this might suggest that their share price should be at least $12.28 per share ($52.817 billion / 4.3 billion shares) -however, given the subjectivity of some of the valuations, such analysis should be taken with a grain of salt -note that AOL apparently has a debt covenant that indicates that they must maintain GAAP Net Worth of $50 billion -another important consideration is that if users of financials ignore a Goodwill Impairment, firms may initially dump as much as possible into Goodwill and then subsequently write it off in order to get certain costs off of the balance sheet -ultimately, AOL and Time Warner split

example: Sycamore Networks IS

-the disclosure of the existence of significant customers can also have important implications for valuation -from 1999 to 2000, revenue went up by a factor of 19, but one customer accounted for 92% and 100% of the company's revenue in 2000 and 1999 -so in order for the company to maintain their pace, they would have to find a lot of customers that they don't currently have

adoption date of FASB #141 and FASB #142 (not super important)

-there was an overlap period, which FASB #142 discussed -any Goodwill from pre 141 combinations would be amortized until the date in which FASB 142 is adopted -any Goodwill that resulted from a combination that occurred after 141 took effect but before a firm adopted 142 should not be amortized

primary beneficiary

-used to describe an enterprise that consolidates a VIE -the Interpretation does not indicate that there must be a primary beneficiary, and allows for the possibility that two (or more) enterprises could look at the same VIE and conclude that they should consolidate it

example of FIN46R disclosures: Disney consolidating Eurodisney

-variable interest entities are entities that lack sufficient equity to finance their activities without additional financial support from other parties or whose equity holders lack adequate decision making ability based on criteria set forth in the interpretation -Disney has global operations, including Euro Disney and Hong Kong International, which they were currently using the equity method for (since they didn't have ownership stake?) -Disney co-signed a lot of the borrowings the VIEs issued, so concluded they they will probably have to consolidate -important note: net income doesn't change whether or not you have to consolidate (shareholders equity also stays the same) -total assets goes up after being adjusted -total revenues goes up

more on Goodwill impairment

-when Goodwill is written-down because it is impaired, the magnitude of the impairment is reported on the income statement before the subtotal "income from continuing operations" -once Goodwill has been written-down, subsequent recovery of the write-off is not allowed -SFAS #142 also indicates that Goodwill should be tested for impairment if an event occurs after which it is more likely than not that the fair value of a reporting unit was less than the carrying value of the reporting unit -a list of factors that could result in this additional testing are: 1. a significant adverse change in legal factors or the business climate 2. unanticipated competition 3. a loss of key personnel 4. a more likely-than-not expectations that a reporting unit or a significant portion of a reporting unit will be sold or otherwise disposed of

example of a goodwill impairment test: MegaOnline

1. calculate the fair value of the reporting unit Media: Media s earnings of $30,000,000 * a price/earnings multiple of 10 = 300,000,000 2. compare this amount to the carrying value (book value) of the reporting unit (=carrying value for that reporting unit when bought +NI earned by that reporting unit for the year) -since the fair value is less than the carrying value, the value of Goodwill is imputed 3. imputed value of goodwill is the fair value of the reporting unit - the fair value of the identifiable net assets of the reporting unit (given in the problem): $300,000,000-$292,000,000 = $8,000,000 4. since the imputed value of $8,000,000 is less than the carrying value of $90,000,000, the Goodwill is considered impaired and the Goodwill will be written down by $82,000,000

goodwill impairment test flowchart: ASU 2011-08

1. qualitative assessment: evaluate relevant events to determine whether it is more likely than not that the fair value of a reporting unit is less than the carrying amount -if the answer is no, then you can stop -if the answer is yes, then continue 2. calculate the fair value of the reporting unit and compare with its carrying amount, including goodwill -if the fair value fo the reporting unit is not less than its carrying amount, you can stop -if it is, then continue 3. calculate and compare implied fair value of reporting unit goodwill with carrying amount of that goodwill -if the implied fair value of goodwill is not less than the carrying amount, you can stop -if it is, then recognize impairment equal to the difference between implied fair value of goodwill and carrying amount of goodwill

operating segments requiring disclosure example

1. revenue test: -10% * total revenue -the reportable segments are those that have total revenue (since this rule is for both unaffiliated/external revenue and inter segment/internal revenue) greater than that amount 2. operating profit (loss) test -10% * the max of those segments with an operating profit or those segments with an operating loss (in other words, you add up the segments with a profit and separately add up the segments with a loss, and whichever number is greater in absolute terms is the one that gets multiplied by 10% -the reportable segments are those that have operating profit (loss) that is greater in absolute terms than that amount 3. asset test: -10% * total assets -the reportable segments are those that have assets greater than that amount 4. -any segment that met the criteria of at least 1 test must be sparely disclosed 5. 75% of unaffiliated revenue test: -75% * total unaffiliated revenue -compare that number to combined unaffiliated sales of the segments you are disclosing -the 75% test is satisfied if segment's combined unaffiliated revenue/total revenue is greater than 75%

control: background and FASB Emerging Task Force Bulletin 90-15

SEC interpreted the term "SubsS-a universally accepted definition of control has proved to be somewhat elusive -lacking explicit accounting guidance to follow, it seems that many financial transactions were recorded in somewhat dubious manners by reference to obscure rules that were seemingly limited in their initial scope -after banks began to securitize receivables, lessors also began to securitize their receivable streams, and thus the EITF provided some guidance as to when special purpose entities related to leasing transactions should be consolidated -FASB Emerging Issues Task Force Bulletin 90-15 requires consolidation if the SPE owner has not made "substantive" equity investment at risk for the entire lease term (if an outsider investor has bought 3% or more of the assets of the SPE, the company didn't have to consolidate -in this particular case, the SEC interpreted the term "Substantive Equity Investment" to mean a minimum of 3% of the assets of the SPE -ex. a SPE could purchase $100 of receivables, financing the purchase by borrowing $97 and having the SPE owner invest $3 of equity, which would be at risk -what proved problematic were the subsequent extrapolations of the 3% rule: the lack of further guidance in this area resulted in the common interpretation that any SPE in which there was more than a 3% independent equity investment need not be consolidated -SOX required a study and report on special purpose entities including: (1) the extent of off-balance sheet transactions, including assets, liabilities, leases, losses, and the use of special purpose entities and (2) whether GAAP rules result in financial statements of issuers reflecting the economies of such off-balance sheet transactions to investors in a transparent fashion -the report included whether GAAP specifically result in the consolidation of special purpose entities sponsored by an issuer in cases in which the issuer has the majority of the risks and rewards of the SPE and any recommendations, etc.